Situation: Family with three kids carries heavy debts, tithing 10 per cent of income, adding more debt Solution: Buy charitable benefits at a discount with life insurance, use freed up cash to cut debt

A couple we’ll call Mel, 38, and Isabel, 33, live in Saskatchewan with their three children — two preschoolers and an eight-year-old. Both have production line jobs with a big manufacturing company. Their combined salaries produce take home income of $5,687 a month. They have large debts to pay, including a $183,024 mortgage with 28 years to run and lines of credit that add up to $68,200 on which they pay just interest at an average 4.5 per cent rate. The debts add up to $251,224, which is 2.4 times their annual pre-tax income.

“How should we be tackling our debts and savings?” Isabel asks. “Which of our loans should we be paying off first?”

Family Finance asked Mathew Hall, a chartered financial analyst and financial planner with Exponent Investment Management Inc. in Ottawa, to work with Mel and Isabel.

“They want to reduce debt aggressively, but they have other goals, such as maintaining a rate of contribution to charitable causes of about 10 per cent of take-home income,” Hall says. “Their expenses exceed income by almost the exact amount of the contributions, but we do not challenge that. Instead, we’ll find solutions to their cash flow problem and a system for financing both the educations of their children and their eventual retirement.”

The cash flow problem

The couple’s financial issues are tied to their beliefs, Hall says. The future total value of the tithe over 22 years between today and Mel’s retirement at age 60, with a two per cent annual increase in salaries, is $200,000. The cash flow issue can be solved with permanent life insurance, which would provide money equal to the present tithe the couple fulfills.

Mel and Isabel are in good health. A joint last to die policy for $200,000 could be obtained for a cost of $170 a month from today to Mel’s retirement. The policy would remain in force and provide the charity of choice with the full value of deferred contributions, from today to 2038. It would then preserve that value and pay when the last partner dies.

The life insurance concept, assuming it is used, will liberate $610 in present donations, less the $170 premiums, for savings of $440 a month. That step will balance the couple’s budget. Further, if all loans are consolidated and secured by their house via a home equity line of credit and set to be paid off in 20 years with a two per cent interest rate, they would need to pay only about $1,200 a month, resulting in savings of $456 a month. The couple’s budget would then be able to support a surplus.

Educating the kids

Mel and Isabel have $10,287 in Registered Education Savings Plans for their children. The cost of attending a provincial institution like the University of Saskatchewan is about $7,000 a year. Using that institution’s cost and adding four per cent per year for inflation in higher education (which tends to run higher than the headline rate for CPI) each child will need an average of $49,000 with the youngest child — last to enroll — needing $53,500 for four years and the eldest needing $44,000.

In order to accumulate these funds, Mel and Isabel should add $240 a month for the eldest child, $140 a month for the middle child and $140 a month for the youngest. That adds up to $520 a month plus the $164 present contributions: $684 a month. The Canada Education Savings Grant, which is the lesser of $500 or 20 per cent of RESP contributions per beneficiary per year, would add 20 per cent to make the monthly contribution $820 for three children.

That additional $520 would exceed their available surplus. However, even if the couple delays contributions for a few years to pay down debts and to build up a rainy day fund, they can tide over their contributions after their youngest child, age 3, ceases to need $650 a month care when entering kindergarten in two years and their eldest child, whose tuition is $475 a month, leaves high school and enrolls in university. With present contributions and four per cent annual returns, the eldest child would have $38,000 for four years of tuition, the middle child $52,500 and the youngest $63,000. The parents can equalize the sums so that each child has $51,200 for four years of university tuition and related expenses. If the kids need more, they could get summer jobs, Hall notes.

Retirement plans

Mel has a defined-contribution pension plan with an $85,000 balance. He contributes seven per cent of his $85,000 annual gross salary as a payroll deduction, and the employer matches it 100 per cent, making his annual contribution $11,900. If he stays with his job for 22 more years and if the balance of the plan grows at three per cent after inflation, the plan would have $537,160 in 2016 dollars when he is 60. That sum, paid out as an annuity to exhaust all capital and income at his age 95, would generate $24,270 a year before tax. Isabel is in a defined-benefit plan that will pay her $12,900 a year with no indexation beginning at her retirement at her age 55.

For the five years to Mel’s age 65, when he can draw full CPP benefits, their income would be $37,170 before tax. With splits of eligible pension income, they could pay tax at a five per cent average rate and have $2,940 to spend each month. Their expenses — with donations covered by life insurance, no mortgage or other debt payments, no tuition costs and perhaps reduced food and clothing costs with the children gone — would be about $2,600. They would have a small margin for savings or other uses.

When Mel is 65, he can draw Canada Pension Plan benefits of $12,780 a year at present rates. Isabel would be able to take $7,423 a year in CPP benefits based on present and estimated future contributions. At 67, each would be entitled to full Old Age Security benefits, about $6,839 a year each. Their permanent and final income would therefore be $71,050 a year. Allowing 14 per cent average income tax, they would have $5,100 a month to spend or use for their children, grandchildren or good causes.

The plan makes no effort to increase RRSP savings, as there is no money for it, and each partner’s employer has a retirement plan. They will have a basic retirement income sufficient to cover expenses even before government benefits are added. The risk is interest rate increases that delay debt paydown. Nevertheless, surpluses will be generated after the kids leave school. Then there will be no need for private school tuition payments nor, after the youngest child is 17, for RESP contributions.

“The critical factor in this plan is deferring the $610 a month charitable donation cost by use of life insurance at a huge monthly saving. If they do that, the plan will work.”